More Consumers Pay Off Their Credit Cards and Let Their Mortgages Go

Last Updated Jun 1, 2010 2:24 PM EDT

If unemployment hits, which bills do you cover first? Traditionally, that would be food, utilities, transportation, and housing. If you couldn't stretch your income to cover credit card payments--well, you let them go.

Such thinking is so pre-2008. Since the real estate meltdown, growing numbers of straitened borrowers are changing their priorities. They're protecting their credit cards and letting their houses go. For anyone who loses a job and has no savings to fall back on, that choice makes a lot of sense.

Pre-2008, your house was your piggy bank as well as your home. If you needed money, you just had to tap your home equity line of credit.

Now, however, you might have no home equity left. If you need emergency money (and, ahem, haven't saved that mythical six-months worth of income in the bank), your credit card is your fastest source of cash.

"People need cards for cash flow," says Suzanne Boas, president of CredAbility (formerly the Consumer Credit Counseling Service of Greater Atlanta), which helps debtors formulate repayment plans. "They're using cards for groceries and gasoline, or for traveling on business." They're even paying more than the minimum, to keep that portion of their credit lives in good repair.

Another reason to hang onto credit cards is that-once lost-they're hard to get back. Lenders are dumping slow-pays and no-pays, exiling them into a purgatory of high rates and low credit lines. That is, if they can get a new card at all.

By contrast, in most states quitting your mortgage payments won't yank your house from under you. Foreclosure can take a year or more, if it has to go through court. By the time the sheriff arrives, you might be employed again or your business might have recovered. At that point, you could do a rescue deal with your bank. If not, well, the house was toast anyway.

The save-your-credit-card-first trend raised its head a couple of years ago and has grown ever more pronounced, according to a study released in February by Transunion, the credit bureau. It began among borrowers with low credit scores but now is creeping into the agenda of high-scoring people, too.

Second homes are the first to go. Then investment properties. First homes go only if they're worth so much less than the mortgage that they don't seem worth keeping any more.

Counseling services help debtors sort out their priorities, create budgets, and figure out what they can afford to pay. The interest rate on their credit card debt averages 20 percent, says CredAbility's spokesperson Scott Scredon. That usually drops to 10 percent or less, if they enter CredAbility's debt management plan, and with late fees erased.

To be accepted into a debt management plans, however, clients have to cut up their credit cards. So they can't take this route if they need their cards for survival during a period of unemployment or to keep a small business alive.

It's not only working people who are struggling with payments. CredAbility is seeing larger numbers of people 70 and up, Boas says. For them, housing cost is now the number two reason for falling into financial stress. (Number one, for all ages, is reduced income or unemployment.) It's also one of the reasons that bankruptcies among this age group are rising sharply.

Remember the financial cliché, "Pay off your mortgage before you retire?" That sounded foolish, pre-2008. People thought that they could sell their homes whenever they wanted and walk away with cash.

In the world of post-2008, that cliché is suddenly sounding fresh.

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